Knowles Corporation

At this time, I'd like to welcome everyone to the Knowles Corporation third quarter 2024 earnings conference call. Please note that this call is being recorded. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. To withdraw your question, press star one a second time. I will now turn the call over to Sarah Cook.

Thank you, and welcome to our third quarter 2024 earnings call. I'm Sarah Cook, Vice President of Investor Relations, and presenting with me today are Jeffrey New, our President and CEO, and John Anderson, our Senior Vice President and CFO. Our call today will include remarks about future expectations, plans, and prospects for NOLS, which constitute forward-looking statements for purposes of the safe harbor provisions under applicable federal security laws. Forward-looking statements in this call will include comments about demand for company products, anticipated trends in company sales, expenses, and profits, and involve a number of risks and uncertainties that could cause actual results to differ materially from current expectations. The company urges investors to review the risks and uncertainties in the company's SEC filings, including, but not limited to, the annual report on Form 10-K for the fiscal year ended December 31, 2023, periodic reports filed from time to time with the SEC, and the risks and uncertainties identified in today's earnings release. All forward-looking statements are made as of the date of this call, and Knowles disclaims any duty to update such statements except as required by law. In addition, pursuant to Reg G, any non-GAAP financial measures referenced during today's conference call can be found in our press release, posted on our website at Knowles.com, and in our current report on Form 8K filed today with the SEC. This will include a reconciliation to the most directly comparable GAAP measure. All financial references on this call will be in a non-GAAP continuing operations basis unless otherwise indicated. We've made selected financial information available in webcast slides, which can be found in the investor relations section of our website. With that, let me turn the call over to Jeff, who will provide details on our results.

Thanks, Sarah, and thanks to all of you for joining us today. Before I move on to the results in detail, I would like to remind you that all financial metrics given on today's call are on a continued operations basis unless otherwise noted, as we signed a definitive agreement in Q3 to sell the consumer MEMS microphone business. The sale will further our strategy of transitioning the company's portfolio to higher growth markets and products where we have high differentiated solutions that drive value for both our customers and shareholders. This positions NOLs for strong growth in both revenue and earnings in the future. As demonstrated by our third quarter results, our total company adjusted EBITDA margins were 24.6%, and as market conditions improved in the PD segment and we realized the full benefit of synergies from the Cornell acquisition, I expect additional margin expansion. Now turning to our results. We continue to deliver on expectations in the third quarter. Revenue of $143 million was at the high end of our guided range, which represents 32% growth on a year-over-year basis, driven by the Cornell acquisition, along with 4% organic growth. EPS of 26 was at the midpoint of our guided range, while cash from operations was $53 million, inclusive of CMM, exceeding the high end of our guided range. On to our segment. In Q3, MedTech specialty audio revenue grew 4% sequentially and 10% on a year-over-year basis. Our continued operational excellence, sustained success of new product adoption, and cutting-edge technology is evidenced by our growth and strong margins. The end market for our hearing health products remains strong, and we're optimistic about our future. In Q3, Apple announced software updates that add over-the-counter hearing aid features to the AirPod Pro 2. Over-the-counter hearing aids address mild hearing loss, which is the least penetrated portion of the hearing health market. We believe these features will continue to drive hearing loss awareness as users will now have a hearing test readily available that could help them in understanding and recognizing hearing loss sooner. This, coupled with the potential of eliminating the stigma of using hearing health device, could drive earlier adoption of traditional hearing aids. Similar to previous years, we are expecting the MedTech and specialty audio segment to finish 2024 strong, with Q4 revenue being the highest of the year, driven by normal seasonality from new product launches within the hearing health market. Looking at our precision device segment, in spite of continued headwinds in inventory levels in the industrial markets, and with our distribution partners, revenue grew 6% sequentially driven by defense and electrification in markets. On a year-over-year basis, revenues grew 57% due to the acquisition of Cornell. I am also pleased with the progress we are making on expanding margins as we improve capacity utilization, productivity, and pricing. Reflecting on our ownership of Cornell this past year, I continue to be excited by this acquisition. We have improved our adjusted EBITDA margins 700 basis points throughout the year by accelerating cost synergies, continual operational improvements, and increased pricing. We have also instilled a disciplined approach to cash deployment leading to increased net operating cash flow. Despite continued challenges in our end markets, Cornell is expected to be accretive in its first year of ownership, a significant milestone, and a critical pillar in our acquisition strategy. As I look forward for the full precision device segment, we expect to see modest sequential revenue growth in Q4. While we have a very healthy pipeline of new opportunities in multiple end markets, which positions us well for growth as the market recovers in 2025, bookings continue to be inconsistent as we have yet to see a sustained recovery in the industrial end market and with our distribution partners. As I noted in the beginning of our call, I am pleased with the signing of the definitive agreement to sell the consumer MEMS microphone business. As already discussed, our quarterly results demonstrate our expanded margin profile as we continue to focus on more attractive growing end markets in the MedTech, defense, electrification, and industrial spaces. I am confident in our ability to deliver shareholder value as we complete this important step in our evolution to a leading industrial technology company. We expect the closing by the end of the fourth quarter and anticipate holding an investor forum in Q1 2025 where we will discuss our growth strategy and plans for the future in more detail. Now let me turn the call over to John to detail our quarter results and provide Q4 guidance. Thanks, Jeff. Please keep in mind all measures that I'll be referencing today are on a continuing operations basis and exclude the consumer MEMS microphone business unless specifically stated. We reported third quarter revenues of $143 million at the high end of the guidance range and up 32% from the year-ago period driven by the acquisition of Cornell in the fourth quarter of 2023 and organic growth of 4%. EPS was $0.26 in the quarter at the midpoint of our guidance range and up $0.06 or 30% from the third quarter of 2023. versus the prior year on higher demand in both hearing health and specialty audio. Gross margins were 53.1%, down 60 basis points versus the year-ago period, driven by unfavorable product mix and slightly lower production yields. The precision devices segment delivered revenues of $79 million, up 57% from the year-ago period, driven by the acquisition of Cornell, partially offset by lower shipments of high-performance capacitors into the distribution channel and to OEMs in the industrial end market as customer and channel inventories remain elevated. Shipments into the medical, defense, and electrification markets were up slightly and in line with expectations. Gross margins were 40%, down 40 basis points from the third quarter of 2023 due to the acquisition of Cornell, partially offset by a 230 basis point improvement in legacy PD margins driven by factory productivity gains. While gross margins at Cornell are below our legacy precision device business, we saw 500 basis point gross margin improvement since Q1 of this year, driven by improved factory capacity utilization, supply chain savings, and higher pricing. On a total company basis, R&D expense in the quarter was $8.9 million, up $1 million from Q3 2023 due to the acquisition of Cornell. SG&A expenses were $24 million, $5 million higher than prior year levels driven by the acquisition of Cornell, partially offset by restructuring actions taken in the second half of 2023 in the PD segment. Interest expense was up $3.3 million versus the prior year due to higher bank borrowings associated with the acquisition of Cornell in the fourth quarter of 2023. Now I'll turn to our ballot sheet and cash flow. In the third quarter, we generated $53 million in cash from operating activities above the high end of our guidance range on lower than expected net working capital and higher cash received from settlement of foreign exchange forward contracts. For the first nine months of 2024, we generated $95 million in operating cash flow, representing a $30 million increase over the first nine months of 2023. Please note that cash from operations for the three and nine months ended September 30 is inclusive of the consumer MEMS microphone business. Capital spending was 4 million in the quarter. During the third quarter, we repurchased 250,000 shares at a total cost of 4.5 million and reduced outstanding bank borrowings under our revolving credit facility by 38 million. We exited the quarter with cash of 93 million and $225 million of debt. That includes borrowings under our revolving credit facility and an interest-free seller note issued in connection with the Cornell acquisition. Lastly, our net leverage ratio based on trailing 12 months adjusted EBITDA was one times. Moving to our guidance. For the fourth quarter of 2024, revenues are expected to be between $141 and $151 million. of 5% versus the year-ago period driven by the acquisition of Cornell. R&D expenses are expected to be between 8 and 9 million, and selling and administrative expenses are expected to be within a range of 23 to 25 million, flat with the prior year. We're projecting adjusted EBIT margin for the quarter to be within a range of 21 to 23%. Interest expense in Q4 is estimated to be 3 million and includes non-cash imputed interest. We expect an effective tax rate of 9 to 13% for the quarter, which is lower than normal due to the utilization of foreign tax credits. We're projecting EPS to be within a range of 26 to 30 cents per share. This assumes weighted average shares outstanding during the quarter of 91.2 million on a fully diluted basis. We're projecting cash from operating activities to be within a range of 30 to 40 million, and capital spending is expected to be $6 million. Cash from operating activities includes $5 to $10 million used by discontinued operations, and capital spending includes $2 million related to discontinued operations. In summary, our third quarter results and fourth quarter guidance highlight the margin profile of our continuing operations. In addition, our increased exposure to attractive end markets, which include med tech, defense, electrification and industrials is expected to drive higher organic revenue growth rates which we will cover in more detail at our investor forum which is planned for q1 of 2025. i'll now turn the call back over to the operator for the q a portion of our call operator thank you if you have dialed in and would like to ask a question please press star followed by the number one on your telephone keypad to raise your hand and join the queue